Fraudulent Guarantees; Fictional Reserve Lending; Comparison of US to Cyprus; What About New Zealand?

Reader "MB" who lives in New Zealand is concerned about confiscation of deposits.
He writes ...

Hi Mish

Apparently articles are appearing in a NZ newspaper editorials saying that
the NZ government has the same policy of confiscation as that being used
on Cyprus by the EU. In the event of a banking crisis, the government will
be able to take deposit funds to bail out a bank.

MB

Theft?

As a super-annuitant who depends on interest from term deposits to top
up my pension, I'm horrified to learn that the Reserve Bank will put in
place a process by which ordinary bank depositors will, without notification
and without their consent, have their savings used to bail out a bank in
financial distress.

If a banking crisis arises, banks will be able to freeze bank accounts
overnight and reopen them the next day, but the account will have been "shaved".

Those of us who suffered loss of retirement savings in the finance institutions'
crashes in 2008 thought we'd be safe keeping the remainder in our banks,
especially the Kiwi-owned bank.

What a shock to learn that our money isn't safe after all.

This is a terrifying prospect for those of us who have no way to replace
any losses because our days of being able to earn are long behind us.

Jill

Open Bank Resolution (OBR) Policy

The OBR policy is designed to ensure that first losses are borne by the
bank's existing shareholders. In addition, a portion of depositors' and
other unsecured creditors' funds will be frozen to bear any remaining losses.
To the extent that these funds are not required to cover losses as more
detailed assessment of the position of the bank is completed, these funds
will be released to depositors. At a high level, this outcome replicates
the outcome that would apply in the event that a failed bank was liquidated.
The primary advantage of the OBR scheme, however, is that depositors would
have access to a large proportion of their balances throughout the process.
This contrasts with what would happen under a normal liquidation, where
depositors might not have access to any of their funds for a significant
period.

Why aren't deposits guaranteed?

During the recent global financial crisis the government took the decision
to put in place a temporary guarantee on retail deposits. On 11 March 2011
the Minister of Finance announced that further guarantees would not be
provided following the expiry of the existing scheme. Furthermore, the
Minister ruled out the possibility of introducing a compulsory deposit
insurance scheme. In coming to this conclusion the Minister noted that
deposit insurance is difficult to price and blunts incentives for both
financial institutions and depositors to monitor and manage risks properly.
The full statement from the Minister can be accessed at http://www.beehive.govt.nz/release/maintaining-confidence-financial-system

The subject of New Zealand is on the verge of going viral. Typically when
that happens, the concern is overblown. And that is precisely the case here.

Sensible Policy

Readers who are unfamiliar with my overall stance on deposit guarantees, especially
in light of my posts on Cyprus may be surprised to learn that I commend the
Reserve Bank of New Zealand's policy for precisely the reasons it stated:

"Deposit insurance is difficult to price and blunts incentives for both
financial institutions and depositors to monitor and manage risks properly."

Consider a US example.

In buildup to the housing bubble crisis, investors flocked to shaky institutions
that paid the highest yields on deposits simply because the deposits were
guaranteed. The FDIC guarantee enabled hundreds of banks such as now-bankrupt
Corus to secure funds used to build condos in Florida and Las Vegas.

No one in their right mind would have placed money in Corus and other such
banks without those guarantees. In essence, deposit insurance helped fuel
the housing bubble.

The difference between the policy of New Zealand and what happened in Cyprus
is the guarantee itself.

The problem in Cyprus was the fraudulent deposit guarantee, made by the ECB,
and repeated just last month by the president of Cyprus.

Fraudulent Guarantees

Guarantees in and of themselves are inherently fraudulent by nature. A look
at money supply numbers will show why.

Base Money

The Adjusted Monetary Base is the sum of currency (including coin) in circulation
outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by
depository institutions at Federal Reserve Banks.

M1

M1 is narrow money supply. It consists of currency, demand deposits (checking
accounts), travelers checks, and other checkable deposits. Travelers checks
are actually double-counted but the numbers are so small the error is essentially
meaningless.

There are better measures of money supply, such as True
Money Supply (TMS) and I encourage you to learn about them. I used
to maintain charts of TMS (I called it M') but Michael Pollaro does a fantastic
job.

I used M1 and M2 above because those are the widely reported numbers, and
the numbers most economists follow.

For the purpose of this discussion, M1, M2, and Base Money supply will suffice.
The next chart will help explain why.

Total Credit Market

Chart Recap

Base Money Supply: $2.9 Trillion

M1: 2.4 Trillion

M2: 10.4 Trillion

Total Credit Market Debt Owed: $56.3 trillion

One Giant Ponzi Scheme

Clearly far more money has been lent than exists. How can it possibly be paid
back? If it can't be paid back, how good is a guarantee?

In 2010 Bernanke proposed ending reserve requirements completely, but long-time
Mish readers understand that is the de facto state of affairs already.

For example, even the $2.4 trillion in M1 money that is "guaranteed" to be
in your checking account and "available on demand" isn't in your checking
account at all. It too has been lent.

I have talked about this before on numerous occasions but it's worth a review.

There are reserve requirements on checking accounts, but you have to take
into consideration the fact that Greenspan allowed sweeps in 1994.

Sweeps allow banks to move (sweep) money from checking accounts into savings
instruments nightly (unbeknown to customers who think the money is really
there in their checking accounts).

Once Greenspan allowed banks to sweep, banks did so in mass, and the end
result is there are essentially no reserve requirements on checking accounts
either.

The bottom lines is banks will continue to do what they have done since
1994, and that is to keep enough reserves on hand to meet estimated withdrawals.

Fictional Reserve Lending

Should banks (large too-big-to-fail banks) run out of reserves, the Fed is
Johnny on the spot, ready and willing to create reserves out of thin air.
However, other banks can't count on it.

In essence, the system is one giant Ponzi scheme (not just in the US but everywhere),
kept afloat by wizards willing to ramp money supply every time big banks get
into trouble.

An enabling factor to all the bank leverage is Fractional Reserve Lending
(which on numerous occasions I have likened to "Fictional Reserve Lending" but
is really better thought of as "Negative Reserve Lending".

Amusingly, people were arguing at the time such policies would soon cause
massive price inflation, but I took the other side of the bet (and still do
- for the time being).

The Fed, was and still is willing to step in and help any "too big to fail" bank,
but numerous small banks went bust in the Great Financial Crisis, and depositors
with money over the FDIC limit did on occasion suffer losses.

In that regard, the Reserve Bank of New Zealand at least has the courage to
tell the truth, with precisely stated reasons: "deposit insurance is difficult
to price and blunts incentives for both financial institutions and depositors
to monitor and manage risks properly"

I am planning a follow-up post on the fraudulent nature of Fractional Reserve
Lending, deposit insurance, and related topics, but the five key points for
now are as follows:

Five Key Points

In a Fractional Reserve Lending scheme, the idea notion there are meaningful
reserves is ridiculous

Far more money has been lent out than really exists (the rest is a fictional
accounting entry)

Fractional reserve lending constitutes fraud (just as lending something
you do not own is fraud)

There is no way for all this money to be paid back (so it won't be)

Of all the central banks, the Reserve Bank of New Zealand has the most
sensible policy for the most sensible reasons of all the central banks.

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